Fundamental analysis is the ultimate driver of stock prices. The general economic climate, the prospects for specific industries and sectors, and how well equipped the company is to take advantage of favorable conditions are obviously the most important things affecting valuation in the long term.
Sometimes however, technical factors, whether based on chart reading or market positioning and dynamics, can be extremely powerful and have the potential to dominate the short-term direction of a stock. That is the case right now with Fuel Cell Energy (FCEL) and a small long position in that stock makes sense.
In this case, the potential for a sharp move is based on what desk and floor traders believe to be the most powerful technical factor of all, market positioning. No matter how much fundamental analysis indicates that a stock is going up, it will struggle to do so if everybody is already long.
The potential for a sudden move down in those circumstances, however, is enormous. Any bad news or shift in the broader economic outlook will result in a rush to exit the trade, and with everybody long, buyers will be few and far between.
The opposite situation, when traders are generally short, has even more potential and that is the case with FCEL. The fact that stock must be borrowed in order to sell it short, and that short positions therefore have a carry cost, makes it that much easier to squeeze short sellers out of their positions.
It should be noted, however, that betting on a short squeeze, while potentially very rewarding, is also very risky. There is usually a very good reason for a short trade becoming crowded - it’s just that sometimes the set-up is too good to ignore.
It has been a tough year for FCEL, and for the fuel cell industry generally. Oil and natural gas prices have stayed low, solar power is becoming cheaper every day, and the success of Tesla (TSLA) has ensured that batteries, not fuel cells, are seen as the future of the automotive industry.
In addition, the current administration has made it clear that fossil fuel expansion will take precedence over alternative energy sources. As a result of those factors and cash flow issues, the stock dropped rapidly at the end of 2016 and into 2017. The vultures started to circle and as short sellers got squeezed out of solar stocks by some strong earnings numbers, they turned their attention to other alternative energy sources.
Short interest in FCEL has therefore climbed, and is now approaching twenty percent of the total float. Even so, FCEL has ground higher since the $0.80 low hit back in May. It is only logical in that situation that some of those shorts are already getting a bit nervous and at some point, traders will be unable to resist piling on the pressure. A full short squeeze looks to be on the cards before too long.
That is made more likely by the fact that FCEL has a decent chance of making a natural, fundamental driven recovery. The situation is certainly grim right now, but there are a couple of projects underway that signal a possible revival. Most notably, Fuel Cell Energy recently signed a twenty-year deal with the city of Tulare, CA.
Somewhat ironically, the current pro-fossil fuel stance of the White House and Congress will make similar deals with some Democratic-controlled states and municipalities more likely in the future, as they push back against that stance and institute their own renewable energy projects.
As I pointed out earlier, there is a lot of risk in a trade like this. A stop loss order can be used to guard against a drift back down, but if bad news were to prompt another big drop, it would be of little use and losses could be large. This is not, therefore, a trade on which to bet the farm. However, a tremendous technical set-up, the possibility of an improving fundamental outlook, and a good risk reward ratio make a small long position in FCEL a trade worth the risk.